Download What Is Driving Food Price Inflation?

2008
What is Driving Food Price Inflation?
By Jason Henderson, Assistant Vice President and Omaha Branch Executive
R
etail food prices surged in 2007, posting their
highest gains in almost two decades. Robust food demand, record high crop prices, and
accelerating costs for labor and energy fueled the sharp
gains in retail food prices. The stage is set for another
round of price gains in 2008.
Today’s momentum in food prices may be signaling a
new era of even higher food prices in the future. Supplies
of agricultural commodities are expected to tighten further
as worldwide populations grow and incomes rise, boosting
demand. As in the past, keeping food prices in check will
depend on whether agriculture can increase supplies by
enhancing productivity.
Food prices soar
Food price inflation in 2007 rose twice as fast as overall
inflation. On an annual basis, 2007 retail food prices rose 4
percent above 2006 levels, outpacing the 2.3 percent gains
in core consumer price inflation, a measure that excludes
the volatile food and energy sectors (Table 1). And, perhaps
more important, food price inflation accelerated as the year
progressed. By December, retail food prices had posted
their biggest annual gain since 1990.
Sharp gains in at-home food prices emerged from all
segments of the food industry, with some of the biggest
gains coming at the meat and dairy counters. After
declining in 2006, dairy prices spiked in 2007, rising 7.4
percent above year-ago levels, with strong export demand
for dried milk underpinning overall dairy prices. Poultry
and pork prices rose sharply after falling in 2006. Robust
meat demand also propelled stronger gains in U.S. beef
prices. Fish and seafood price inflation held steady.
Crop-based food products experienced rapid price
gains as well. After modest price gains the past three
years, cereal and bakery product prices jumped 4.3
percent in 2007. Strong demand, both domestically and
internationally, underpinned sharp 2.9 percent gains in
fat and oil product prices. Fruit and vegetable price gains
eased after U.S. production rebounded from a freezedamaged crop in 2006. In contrast, price inflation for
processed fruits and vegetables accelerated, reflecting higher
processing costs.
In 2008, food price inflation is expected to ease but
remain high by historical standards. In December, the
U.S. Department of Agriculture (USDA) forecast annual
food price inflation to range between 3 and 4 percent,
below 2007 gains but well above the ten-year average of
2.6 percent. The strongest price pressures are expected to
emerge from cereal and bakery products and fats and oils,
where prices are expected to rise more than 5 percent. In
contrast, meat, poultry, fish, and dairy price increases are
expected to slow, rising less than 3 percent.
2 0 0 8 • Vo l I I I I s s u e I
Table 1
Consumer Food Prices
Item
Relative
importance1
Final
2006
Final
2007
Forecast
20082
Percent
All food
100.0
3.4
2.4
2.4
4.0
3.0 to 4.0
Food away from home
43.1
3.0
3.2
3.1
3.6
2.5 to 3.5
Food at home
56.9
3.8
1.9
1.8
4.2
3.5 to 4.5
14.5
7.4
2.4
0.8
3.8
2.0 to 3.0
Meats
Percent change
9.3
8.4
2.3
0.7
3.3
1.5 to 2.5
Beef and veal
4.5
11.6
2.6
0.8
4.5
2.0 to 3.0
Pork
3.0
5.7
2.0
-0.3
2.0
1.0 to 2.0
Other meats
1.9
4.4
2.3
1.8
2.3
0.0 to 1.0
Poultry
2.7
7.5
2.0
-1.8
5.2
1.5 to 2.5
Fish and seafood
2.4
2.3
3.0
4.7
4.6
3.0 to 4.0
Eggs
0.7
6.1
-13.6
4.8
29.4
-3.0 to -2.0
Dairy products
5.9
7.4
1.2
-0.6
7.4
2.0 to 3.0
Fats and oils
1.6
6.6
-0.1
0.2
2.9
5.0 to 6.0
Fruits and vegetables
8.7
3.0
3.8
4.8
3.8
3.0 to 4.0
6.9
3.5
3.9
5.3
3.9
3.0 to 4.0
Fresh fruits
3.6
2.8
3.7
6.0
4.5
3.5 to 4.5
Fresh vegetables
3.4
4.3
4.1
4.6
3.2
2.5 to 3.5
1.8
1.3
3.3
2.9
3.6
3.0 to 4.0
Sugar and sweets
2.2
0.7
1.2
3.8
3.1
2.0 to 3.0
Cereals and bakery products
7.9
1.6
1.4
1.9
4.3
5.5 to 6.5
Nonalcoholic beverages
6.5
0.4
2.9
2.1
4.1
3.5 to 4.5
Other foods
8.7
0.5
1.5
1.4
1.8
2.5 to 3.5
Fresh fruits and vegetables
Processed fruits and vegetables
2
Final
2005
Consumer price indexes
Meats, poultry, and fish
1
Final
2004
BLS estimated expenditure shares, December 2006.
USDA Forecast, December 2007
Marketing costs drive retail food prices
Marketing costs have risen sharply over the past 50
years, consuming a greater share of the retail food dollar.
In 1950, marketing costs (the difference between the farm
value and consumer spending for food at grocery stores
and restaurants) accounted for 59 percent of total retail
food costs. Over the past three decades, rising labor and
energy costs have boosted that share steadily, from 67
percent in the 1970s to 80 percent today.
Labor costs have emerged as the biggest component
of the retail food dollar. Labor is used to process and
manufacture food, serve food at restaurants, and sell
food at supermarkets and other food stores. Labor costs
have risen as people have consumed more processed and
prepared foods and increased away-from-home food
consumption. In 2004, labor costs accounted for 38.5
percent of the total food marketing bill, up from 28
percent in the 1970s (Chart 1).
In the year ahead, labor costs are expected to fuel food
price increases. As 2007 ended, both food manufacturers
and food service firms were adding employees at higher
wage levels. Food manufacturers bucked national
manufacturing trends for the year by expanding payrolls
0.9 percent annually and raising wages faster than the
national average. Food service companies also recorded
robust employment and wage gains. Average weekly
earnings and employment rose 5.2 percent and 3.7
percent, respectively. While a weaker labor market in 2008
could ease some of the wage pressure, elevated labor costs
will contribute to higher food prices.
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Chart 1
Components of retail food costs
Nevertheless, the inherent volatility of energy markets
makes the impact of energy on food prices highly uncertain.
Farm commodities still fuel food price gains
Transportation
4.0%
Labor
38.5%
Energy
3.5%
Packaging 8.0%
Profits 4.5%
Rent 4.5%
Advertising 4.0%
Depreciation 3.5%
Farm Value
19.5%
Other Costs
2.5%
Source: USDA
Repairs
1.5%
Taxes 3.5%
Interest 2.5%
While marketing costs have increased over time,
farm commodity prices have remained relatively stable.
Thus, the farm commodity share of retail food prices
has diminished. Still, farm commodities account for a
substantial part of the retail food dollar, and the two
continue to move in tandem.
In 2005, farm commodities accounted for 20 percent
of retail food costs, down from 41 percent in the 1970s. In
other words, for every retail dollar spent on food, 20 cents
goes toward farm commodities. This amount is less than
half that of three decades ago.
The farm commodity share of the retail food dollar,
however, varies by the type of food group. Commodities
represent a larger percentage of retail costs for foods
requiring less processing, packaging, or advertising.
For example, in 2005, commodities represented about
45 percent of retail beef costs and about 25 percent of
retail fruit and vegetable costs. In contrast, commodities
accounted for only 6 percent of retail cereal and bakery
costs. Even within the cereal and bakery group, farm
costs can vary dramatically with the level of processing.
USDA reports that farmers receive 19 cents from every
dollar spent on a bag of wheat flour, but only 5 cents from
a dollar spent on a loaf of bread and just 4 cents from a
dollar spent on a box of corn flakes.
Energy prices are also a large component of the
retail food dollar, boosting prices by raising the costs of
processing, manufacturing, and transporting food. For
example, in the late 1970s and early 1980s, high energy
prices accounted for almost 9 percent of retail food
costs. During the 1990s, energy prices eased and energy
efficiency increased, diminishing the contribution of
energy costs to the retail food dollar. In 2005, the most
recent year for which data are available, direct energy costs
Chart 2
and transportation costs accounted for roughly 8 percent
Farm value share of retail food costs, 2005
of retail food costs.
Surging energy costs will also translate into higher
Beef
food prices in 2008. In January, energy prices soared as
Pork
crude oil prices exceeded $100 per barrel. At the same
Dairy
time, gasoline prices breached the $3 mark, and diesel
Fresh Vegetables
fuel costs soared. Futures prices indicate that energy prices
should remain high.
Fresh Fruit
Historically, food prices have surged during times
Processed Fruit and Vegetables
of higher crude oil prices. Moreover, research shows that
Fats and oils
energy prices are quickly passed through to higher retail
Cereals and Bakery
food prices, with retail prices rising 1.82 percent in the
0
10
20
30
40
short-term for every 100 percent rise in energy prices (Reed
Farm Value Share
Source: USDA
et al.). More recent research suggest stronger impacts.
50
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In short, both the decline in the relative importance
of farm commodity costs over time and the variation
across food groups reflect the level of processing and other
marketing costs involved in preparing the farm commodity
for the consumer. Today, people are eating more
processed foods and consuming more food away from
home. Processed foods and restaurant meals have higher
marketing costs. And across food groups, packaged food
with substantial advertising and specialized marketing,
such as cereals, have higher marketing costs, contributing
to lower farm costs per retail food dollar.
The farm commodity share of the retail food
dollar has also been declining because increases in farm
commodity prices have been relatively modest. After
rising sharply in the 1970s, commodity prices have been
relatively flat, even with annual price spikes. For example,
U.S. corn prices averaged $2.10 from 2000 to 2005,
equaling the average annual price of corn in the 1970s. A
similar story emerged for wheat, soybeans, pork, beef, and
milk prices.
In 2007, however, farm commodity prices surged, and
further gains are expected in 2008. By December, farmlevel prices for food commodities had jumped 30 percent
above 2006 levels. A summer rebound in milk, cattle,
and hog prices, coupled with a winter rally in soybean,
wheat, and corn prices, fueled the sharp rise in farm-level
prices. Adding additional pressure to crop prices in 2008
are lean world grain inventories, which are expected to
drop to record lows.
Historically, farm commodity prices have moved
in tandem with retail food prices. The two are expected
to move together in 2008. Stronger crop prices parallel
the sharper inflation forecasts for cereal, bakery, fat, and
oil products. At the same time, however, livestock prices
are expected to fall in 2008 with slower retail food price
inflation in meat and dairy products.
A new era of high food prices?
The sharp rise in farm commodity prices may
be signaling a new era of higher food price inflation.
Robust demand for farm commodities could outstrip
existing production capabilities, straining food supplies
and boosting prices. Moreover, population growth and
rising incomes are altering global food consumption
patterns and boosting the demand for food, further
supporting higher prices.
Global crop inventories have dropped to record
lows, due in part to the increased use of agricultural
commodities in nonfood products. World food supply
discussions often focus on crop inventories because
they are the foundation for most global food diets and
livestock feeds. In the 2008 crop year, global wheat and
coarse grain inventories are expected to fall to historical
lows, with only 14 percent of annual consumption, or less
than two months supply, expected to be held in reserve.
Robust demand for bio-fuels, especially in the United
States, has led to a decline in corn inventories, despite a
record corn crop. An increase in U.S. corn acres limited
the production of other crops. Globally, drought-reduced
harvests further trimmed grain supplies.
Meanwhile, expanding global populations and rising
incomes are also straining global food supplies. Global
populations rose steadily in 2007, reaching 6.7 billion,
compared to 5.8 billion people a decade ago. More
important, rising global incomes, especially in developing
countries, are changing food consumption patterns and
boosting food demand. As incomes rise, people not only
increase how much food they buy, but also the types of
food they eat. For example, the per capita caloric intake
of people in developed countries is 24 percent higher than
people in developing countries, with most of the difference
coming from protein consumption.
With about a fifth of the world’s population, China is
already leading a sea change in world food consumption
patterns. Brisk economic gains are boosting the demand
for proteins and the crops needed to feed animals. For
example, since the mid-1990s, per capita world oilseed
consumption has jumped 35 percent, led by the increased
consumption in China.
If world population and income growth rates persist,
rising food consumption could strain existing production
capabilities. Assuming that the recent gains in per capita
oilseed consumption, agricultural productivity, and planted
acres continue at current rates, the demand for world
oilseed consumption could outpace production over the
next decade, placing upward pressure on prices (Chart 3).
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Chart 3
Projected World Oilseed Consumption
and Production
650
References
Million metric tons
650
600
600
Projected Consumption
(Based on population growth and
rising per capita consumption)
550
550
500
500
450
450
Projected Production
(Based on productivity growth)
400
400
350
350
300
300
250
250
200
200
1996
2000
2004
2008
2012
U.S. Department of Agriculture, Foreign Agricultural
Service, Production Estimates and Crop Assessment
Division. 2003. “Brazil: Future Agricultural
Expansion Potential Underrated,” January 14, www.
fas.usda.gov/pecad2/highlights/2003/01/Ag_expansion/.
2016
2020
Reed, A.J., Kenneth Hanson, Howard Elitzak, and Gerald
Schulter. 1997. “Changing Consumer Food Prices: A
User’s Guide to ERS Analyses” Food and Consumer
Economics Division, Economic Research Service,
U.S. Department of Agriculture. Technical Bulletin
No. 1862, January 14, www.ers.usda.gov/publications/
TB1862/tb1862.pdf.
Sources: Calculations based on USDA and U.S. Census Bureau data.
Notes: Agricultural productivity and per capita consumption growth from 1994 to
2007 are expected to hold through 2020.
To meet the growing demand, agriculture will need
to put more acres to the plough. For example, over the
past decade, South America has bolstered its planted
soybean acres. In 2003, USDA reported that Brazil had the
potential to fulfill future world soybean demand.
But environmental concerns, water access,
transportation infrastructure, financing, and other political
issues might limit agriculture’s potential (USDA). In light
of such constraints, boosting agricultural productivity may
be the best option for expanding global food supplies.
Historically, technological advances have enabled
farmers to boost agricultural productivity to meet rising
global demand. From 1900 to 2000, U.S. corn acres fell
almost 25 percent, but corn yields jumped 387 percent.
In the 1970s, a Green Revolution propelled a global surge
in crop productivity. More recently, genetically modified
crops have brought the promise of another revolution
in agricultural productivity, which has slowed since the
1980s. New productivity gains could relieve some of the
pressure on existing crop supplies and food prices.
Retail food prices surged in 2007 as prices accelerated
for farm commodities, energy, and labor. Another sharp
gain is expected for 2008, emerging primarily from foods
made from crops. With global food demand projected to
rise due to expanding populations and rising incomes, the
productive capacity of the agricultural sector will be tested.
But, as in the past, stronger agricultural productivity could
help keep higher food price inflation at bay.
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